Becoming your own boss might be the key factor for many people in deciding to buy a franchise, but it’s the profitability and financial performance of the business that provides real satisfaction for franchisees according to financial benchmarking and profit specialist David Campbell.

And while the business model is important in determining profitability, it is often the franchisees themselves that are their own worst enemy in achieving a healthy bottom line. 

Campbell has reviewed the financial performance of literally hundreds of franchisees around Australia across dozens of franchise brands, and consistently reaches the same conclusion.

“Franchisees who fail to plan, plan to fail,” he says.

“We have looked at the financials of so many businesses and often see franchisees who are looking everywhere for the cause of their problems, instead of themselves,” says Campbell.

Key Performance Indicator (KPI) # 1 – Calculate your living costs

One of the biggest problems is that many people going into business for themselves for the first time, (whether franchised or independent), rarely take the time to work out what they need to achieve from the business just to cover their living costs.

“One of the first things you need to do is to work out what it costs you to stay alive – to pay the rent or mortgage, buy groceries, pay bills, put the kids through school, annual holidays etc. This can add up to a surprisingly large amount for many people, and this helps set one of the first benchmarks because it becomes the absolute minimum level of return (in terms of owner’s drawings and profit) that the business should achieve,” according to Campbell.

“As simple as this might sound, it is staggering the number of people in business who don’t know what it costs them to live, and therefore what their business should be providing them at a minimum.

Key Performance Indicator (KPI) # 2 – Match the debt with the asset

“When borrowing to buy a franchise, the term of the loan should be the same as the duration of the franchise,” says Campbell.

”This means that franchise buyers who draw against their 20-year home loan for a five year franchise are kidding themselves as to the true cost of the interest over the term of the business. While at first the repayments may seem lower, they fail to realize that they will be servicing the debt long after they have sold or left the business.”

This is the same approach as ensuring that any lease for premises also matches the term of the agreement – usually around five years – but does not lock the franchisee into paying rent for years after the franchise has ended.

Key Performance Indicator (KPI) # 3 – Business costs are business costs

“We often hear owners complain about a lack of profitability in their business, but when we look at the finer detail, we pick up a lot of personal expenses that are put through the business and which artificially reduce the size of the profit,” says Campbell.

Once these costs – which could be described as owner’s drawings in a different form – are added back, the business can demonstrate sustainable profitability in keeping with the franchisor’s business model.

“The difference can often be substantial, and in most cases is done to minimize tax, but causes a wider long-term problem by depressing the sale price of the business,” explains Campbell.

“Businesses are bought and sold on their ability to generate profit, and so a business that shows little or no profit will be worth little or nothing to a potential buyer. May franchisees sabotage their own exit plans by unnecessarily loading expenses through their businesses.”

Key Performance Indicator (KPI) # 4 – Pay yourself what the job is worth

In some cases, franchisee profitability is under or over reported because franchisees don’t either pay themselves enough, or pay themselves more than the business can bear.

For example, Campbell cites a husband and wife couple who showed a whopping profit for the year, but had failed to allocate themselves as a cost to the business. In other words, they were not drawing a wage or salary, and simply counted the entire surplus at the end of the year as their profit.

‘”The problem with this is that they are fooling themselves that their business is more profitable than it really is,” he says.

“On the flipside of that are people who might have had $100,000 jobs in the workforce who continue to pay themselves at that rate when they are running a business for which the market rate for the job of managing that business might be only $50,000,” states Campbell.

“What that means is they are paying themselves an unsustainably high amount, reducing the profits of the business by $50,000 a year or even causing it to show a loss. Many owners fail to pay themselves what the job of running that business is otherwise worth on the open market, and this can distort their profit figure.”

Key Performance Indicator (KPI) # 5 – Get the margins right

In groups analysed by Campbell’s firm Avatar Business Navigators, margins added to the cost of goods or services sold have varied by as much as 40%, resulting in huge variations on the bottom lines of businesses that are outwardly similar, but achieving very different profit results.

“A variation of this magnitude is huge, and a good system-wide benchmarking process will allow franchisors and frachisees to identify businesses, products and services with the greatest margins, and work out improved ways of selling them,” says Campbell.

Key Performance Indicator (KPI) # 6– Keep the expenses under contol

Similar to the high spread in margins, Campbell has also found that the difference between high and low-performing franchisees in a group is their expenses as a percentage of turnover.

“In some instances we have seen differences of nearly a third between strong and poor-performing franchisees, whose high expenses are robbing them profit,” he says.

Key Performance Indicator (KPI) # 7 - Sell more

It’s not rocket science. Some franchisees can do it really well, and others are not so good at it, but being able to sell is fundamental to the success of any business.  A quality benchmarking program will link sales success with promotional activity, and when highly evolved, can result in franchisee’s predicting with some accuracy their likely sales increases from a given marketing activity.

Key Performance Indicator (KPI) # 8 – 1 + 1 + 1 = A lot more than 3

To illustrate his point about getting the margins right and keeping costs under control, while at the same time increasing sales, Campbell cites an example that a 1% increase in price, accompanied by a 1% increase in margin (which could be achieved by either increasing prices or through better buying) and a 1% increase in sales can result in a massive 26% increase in profit.

The final Word

The bottom line for many business owners is fluid, and can go up and down through one or more changes to the operation of the business. By comparing the key variables against other, higher-performing franchisees in a system, an ongoing process of benchmarking can result in strong positive gains for both the business and its owners.

David Campbell is a co-presenter of the Financial Benchmarking & KPI's for Franchisors and Franchisees seminars organised by the Franchise Advisory Centre. For more information on these seminars, click here .